Page 564 - Accounting Principles (A Business Perspective)

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influence over the investee company. In certain cases, a company may have significant influence even when its
investment is less than 20 per cent. In either situation, the investor must account for the investment under the
equity method.

When using the equity method in accounting for stock investments, the investor company must recognize its
share of the investee company's income, regardless of whether or not it receives dividends. The logic behind this
treatment is that the investor company may exercise influence over the declaration of dividends and thereby
manipulate its own income by influencing the investee's decision to declare (or not declare) dividends.
Thus, when the investee reports income or losses, the investor company must recognize its share of the
investee's income or losses. For example, assume that Tone Company (the investor) owns 30 per cent of Dutch
Company (the investee) and Dutch reports USD 50,000 net income in the current year. Under the equity method,

Tone makes the following entry as of the end of 2010:
Investment in Dutch Company (+A) 15,000
Income from Dutch Company ($50,000 x 0.30) 15,000
(+SE)
To record 30% of Dutch Company's Net Income.
The USD 15,000 income from Dutch would be reported on Tone's 2010 income statement. The investment
account is also increased by USD 15,000.
If the investee incurs a loss, the investor company debits a loss account and credits the investment account for

the investor's share of the loss. For example, assume Dutch incurs a loss of USD 10,000 in 2011. Since it still owns
30 per cent of Dutch, Tone records its share of the loss as follows:
Loss from Dutch Company ($10,000 x 3,000
0.30) (-SE)
Investment in Dutch Company (-A) 3,000
To recognize 30% of Dutch Company's
loss.
Tone would report the USD 3,000 loss on its 2011 income statement. The USD 3,000 credit reduces Tone's

equity in the investee. Furthermore, because dividends are a distribution of income to the owners of the
corporation, if Dutch declares and pays USD 20,000 in dividends, this entry would also be required for Tone:
Cash (+A) 6,000
Investment in Dutch Company ($20,000 x 0.30) (- 6,000
A)
To record receipt of 30% of dividends paid by Dutch
Company.
Under the equity method just illustrated, the Investment in the Dutch Company account always reflects Tone's
30 per cent interest in the net assets of Dutch.
Reporting for stock investments of more than 50 per cent

In recent years, many companies have expanded by purchasing a major portion, or all, of another company's
outstanding voting stock. The purpose of such acquisitions ranges from ensuring a source of raw materials (such as
oil), to desiring to enter into a new industry, or seeking income on the investment. Both corporations remain
separate legal entities, regardless of the investment purpose. In this section, you learn how to account for business
combinations.
As stated in the introduction to this chapter, a corporation that owns more than 50 per cent of the outstanding
voting common stock of another corporation is the parent company. The corporation acquired and controlled by

the parent company is the subsidiary company.

Accounting Principles: A Business Perspective 565 A Global Text